7TH PAY COMMISSION HRA IMPACTS INFLATION BY 35BPS- RBI STAFF STUDY

Increase in HRA by the Centre from July 2017, pushed up housing inflation significantly with concomitant impact on headline inflation according to an RBI staff paper. An analysis of CPI by the authors shows that the 7th pay commission's HRA increase pushed up headline inflation prints gradually from July 2017, with a peak impact of about 35 bps.

According to the paper under the series ` Mint street memos'. Increase in HRA by the central government from July 2017, pushed up housing inflation significantly and in turn headline inflation. Since the middle of last year, revision in house rent allowance (HRA) for government employees, has pushed upward measured inflation. The paper first explains the method of housing index compilation and demystifies the way of assessing the impact of HRA on headline inflation. Second, it measures the of housing inflation before and after the increase by the 7th Central Pay Commission (CPC).

The impact is seen across most States and Union Territories. So far, the actual impact of the HRA increase on headline consumer price index has turned out to be similar to the Reserve Bank's assessment in the Fifth Bi-monthly Monetary Policy Statement, December 2017

According to RBI's projection given a sharp increase in rentals of sample dwellings, headline inflation was expected to gradually increase over six months, remain elevated for another six months, and peter out of the effect thereafter. If HRA increased by 105.6 per cent, with the weight of house rent at 9.51 per cent in CPI, the peak increase in headline inflation works out to around 140 basis points (bps). This increase sets in gradually as one-sixth of these houses are visited each month starting July 2017 and fades out in 18 months.

The note highlights the sensitivity of CPI inflation to changes in HRA under CPC awards. However, the analysis has some limitations as it presupposes that the rental behaviour of other than government houses remains unchanged.